I'm the traditional sort, so I use my late father's old dictionary. Many things have changed since Houghton & Mifflin published it nearly 40 years ago, including this whole internet thing, so maybe it's finally time to upgrade. Nevertheless, it's also true that some things have not changed, and surely the meaning of the word "dividend" is one of them.

Written by the stodgy antiquarians at American Heritage, my father's dictionary defines the word "dividend" as "a share of profits received by a stockholder or a policy holder in a mutual insurance society." Since many non-traded REITs habitually pay dividends using money from new investors and borrowings- not profits- whose dictionary must they be using?

Paying dividends using offering proceeds and/or borrowings is deceitful and lazy, never mind financially illiterate, and it puts overall shareholder returns in great jeopardy. It's deceitful because investors are told their money is beng invested in real estate, but it's not being invested in real estate. It's lazy because it allows sponsors to fake the whole thing, just like a man named Madoff.

Rather than doing the hard work of creating a portfolio that will support reliable dividends and capital appreciation over time, sponsors simply buy themselves a free pass using shareholders' cash to pay dividends. Non-traded REIT sponsors all know this is deceitful and lazy, but they pay dividends with offering proceeds anyway. Why? Because it helps them achieve their true objective, which is the sale of still more shares. In addition to being deceitful and lazy, the practice of paying dividends out of offering proceeds is also completely poisonous, and it should be illegal.

For a real life "cradle to grave" illustration of just how poisonous this is, look no further than Behringer Harvard, a non-traded REIT sponsor based in the financial capital of Addison, Texas. This company is in the midst of producing a string of real life REIT Wrecks, including Behringer Harvard REIT I ("BHRI"). BHRI began life in October 2003, at which time Behringer Harvard management immediately began paying dividends out of offering proceeds. Since that time, Behringer Harvard REIT I has never covered its dividend with real operating cash flow. Furthermore, in all but one year, the majority of the "dividend" came simply from returning shareholders' own money. In fact, As of December 31, 2009, BHRI had paid dividends that totaled more than three times its reported Funds From Operations from 2003 through 2009. Overall, 89% of the dividend constituted a return of capital:

Would You Like Sugar With That Bitter Pill??

Six Years of Behringer Harvard Poison.jpg (67.76 KiB) Viewed 27808 times

Just as water will always flow downhill, this practice will always erode shareholders' principal. Indeed, on May 18th 2010, Behringer Harvard filed [url=http://www.sec.gov/Archives/edgar/data/1176373/000110465910029381/a10-10472_18k.htm]this statement[/url] with the SEC, disclosing that it had revalued the shares from $10.00 to $4.25. This would be a 57% loss - that is IF Behringer Harvard's estimates and assumptions do not "prove later to be inaccurate or incomplete." For dessert, Behringer Harvard slashed the dividend to almost zero. Sadly, Behringer Harvard had long ago eliminated the BHRI shareholder redemption program, [url=http://www.reitwrecks.com/forum/viewtopic.php?f=2&t=24]so you can't sell even if you're dead[/url], and the REIT itself can't be sold because its portfolio is full of sludge. That means you're stuck.

What happened? Among other things, Behringer Harvard consistently used investor proceeds to pay dividends, rather than invest the money in income producing real estate. Unfortunately, the same results that Behringer Harvard manufactured with BHRI are now being produced at its sister REIT, Behringer Harvard Multi-Family REIT I (BHMFI). This REIT is literally a disaster in waiting, chock full of 2006-2007 vintage development deals, mezzanine debt and stuctured equity. It is simply not suitable for unsophisticated retail investors, but it's sold to them anyway. Furthermore, in 2008, Behringer Harvard Multi-Family REIT I did not even come close to covering its 6.5% dividend (according to the 10-K, it was only 58% covered by FFO), yet management somehow decided it would be wise to raise the dividend to 7.0%.

How did this REIT fare in 2009? That depends on your perspective. If you're a shareholder, you're in big trouble. The portfolio produced FFO of negative $700,000, yet management somehow decided to declare dividends totaling $22.7 million. If you're the sponsor, on the other hand, things are looking great: the ill-advised dividend increase helped BHMFI raise $400 million more in equity than the year before!

Whether the SEC continues to tolerate this nonsense is an open question. My educated guess is that they may not tolerate it much longer. All I can say is that it's about time. As [url=http://www.forbes.com/forbes/2005/0509/078.html]Forbes wrote critically in 2005[/url], the practice of "paying dividends with sawdust and promises is rampant among private REITs." Ironically, Forbes used Behringer Harvard REIT I, among others, as an example of this poisonous behavior. The results of paying dividends with sawdust and promises are now in, and it seems pretty obvious that this practice needs to end.

The Behringer Harvard Multifamily REIT is following BH REIT I's footsteps. A 7.25% dividend ( I think) and a negative FFO in the first quarter. A read of the REIT's most recent 10-Q brings to question whether this REIT will ever even have positive FFO, let alone cover its dividend.

The high dividends are teaser rates for brokers and investors. The fees on non-traded REITs require acquisition cap rates 1.5% to 2.0% higher than the distribution rate. All these REITs are looking at the same properties, and none have a that much a competitive advantage where they can pay a 100 basis point higher dividend. As my one of my college professors used to say, "there is no free lunch," and there is a price for buying a REIT paying a high dividend not covered by operations. Broker / dealers need to push back on phony dividends. As long as BH can raise $50 million a month and lower yielding REITs don't raise nearly as much, BH and imitators will keep paying phony dividends.

My post last night was wrong when I said BH Multifamily was paying a 7.25% distribution, it is paying a 7.00% distribution. BH Multifamily filed an 8-K June 1, which confirmed the 7.0% distribution. The 8-K had some strange and confusing language and sounds like a hedge for a future distribution cut.

Thanks. I read the [url=http://www.sec.gov/Archives/edgar/data/1384710/000110465910031827/a10-11332_18k.htm]June Ist 8K[/url], and this is the language that confused me:

We continue to believe that the current distribution rate is reflective of current market conditions for investments suitable for our portfolio and one that can be sustained after we complete our initial public offering

Do you think Behringer Harvard management is on acid? Or maybe Jason Mattox is spending too much time at the hairdresser? What else could explain such an absurd statement?

Related Post:

More on this general topic at [url=http://rationalrealist.blogspot.com/]Rational Realist[/url]

"We have done what all non-traded REITs do which is to market our program at an unachievable dividend knowing full well we would "right size", er, lower the dividend at the end of the offering period to reflect the income thrown off by the mediocre properties we acquired. All this will be done in anticipation of a public offering, which cannot be effectuated at our original pie-in-the-sky distribution rate. Of course we will be internalizing the advisor to the tune of untold millions so we expect our shareholders to take it further in the rear-end while we enrich ourselves unjustly. We thank all of the financial advisors for helping us perpetrate this fraud on unknowing and less than diligent retirees who blindly entrust their retirement nestegg to our lousy but legal programs. We would also like to tip our hat to our own wholesalers, who often misrepresent our product to the advisors, 90% of which take what we say at face value. It is comforting to know that it is the financial advisors, not our own salesmen, that will bear most of the blame for the complete destruction of shareholder value in these programs."

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